Quick Answer
A letter of credit (L/C) is issued by the issuing bank at the buyer’s request, undertaking to pay when the seller presents documents that comply with the credit’s terms. It replaces “the buyer’s credit” with “the bank’s credit”, but banks examine documents only, not goods. Most L/Cs are subject to the International Chamber of Commerce’s UCP 600: under Article 3, a credit is irrevocable even if it does not say so; under Article 14, banks have a maximum of 5 banking days to examine documents. For sellers, the key is that documents must strictly comply with the L/C terms.
The Four Main Parties to a Letter of Credit
| Party | Role |
|---|---|
| Applicant (buyer) | Applies to the bank to issue the credit |
| Issuing bank | Issues the credit and undertakes to pay |
| Advising bank | Notifies the seller of the credit in the seller’s location |
| Beneficiary (seller) | Ships and presents documents for payment |
There may also be a negotiating bank and a confirming bank.
The Letter of Credit Process
- Buyer and seller agree in the contract to pay by letter of credit.
- The buyer applies to the issuing bank.
- The issuing bank issues the credit, and the advising bank notifies the seller.
- The seller reviews the terms and requests amendments if needed.
- The seller ships as agreed and obtains the bill of lading and other documents.
- The seller presents documents to the bank within the deadline (negotiation); see L/C Negotiation Process.
- The bank examines the documents and pays or accepts if they comply.
- The buyer pays, takes up the documents and collects the goods.
Key UCP 600 Rules
| Article | Key point |
|---|---|
| Article 3 | A credit is irrevocable even if there is no indication to that effect |
| Article 14(b) | Examination period: a maximum of 5 banking days following the day of presentation |
| Article 38 | Transferable credits: a bank transfers only to the extent and in the manner expressly consented to |
Transferable credits are common in triangular trade: the intermediary transfers part of the buyer’s credit to the supplier.
Pros and Cons of Letters of Credit
| For the seller | For the buyer | |
|---|---|---|
| Pros | Bank credit replaces buyer credit, so payment is more secure | The seller is paid only after presenting complying documents |
| Cons | Discrepant documents may be refused; higher fees | Uses bank credit lines and incurs issuing fees; banks check documents, not goods |
Discrepant Documents: The Most Common Risk
Banks decide compliance on the face of the documents. Common discrepancies include inconsistent goods descriptions, late shipment or presentation, mismatched quantities or amounts, missing copies and unendorsed bills of lading. To control them:
- Review every clause as soon as you receive the credit, and request amendments for anything you cannot meet.
- Prepare a document checklist before shipment.
- Keep descriptions, quantities, amounts and dates consistent across documents; see International Trade Documents Explained.
How Tang Sugar Can Help
Tang Sugar’s triangular and multilateral trade service arranges payment terms (L/C, T/T) and invoice structures and coordinates commercial invoices, packing lists and bills of lading so documents match the L/C terms. Contact us.
FAQ
What is a letter of credit?
A document issued by a bank at the buyer’s request, undertaking to pay when the seller presents documents complying with its terms, replacing the buyer’s credit with the bank’s.
Can a letter of credit be revoked?
Under UCP 600 Article 3, a credit is irrevocable even if it does not say so.
How long do banks take to examine L/C documents?
Under UCP 600 Article 14(b), a maximum of 5 banking days following the day of presentation.
Can letters of credit be used in triangular trade?
Yes. Common approaches are a transferable credit or a back-to-back credit issued by the intermediary; transferable credits follow UCP 600 Article 38.
What fees does a letter of credit involve?
Commonly an issuing fee (charged by the importer’s bank), advising fee, negotiation fee, amendment fee, and where needed confirmation fees and courier or telecommunication charges. Amounts and who pays depend on the parties’ agreement and each bank’s tariff.
How do you read a letter of credit?
Check the beneficiary and applicant names, amount and currency, expiry date and latest shipment date, ports of loading and discharge, goods description, required documents (such as commercial invoice, bill of lading, packing list and certificate of origin), and whether partial shipments and transshipment are allowed. Request amendments before shipment for any clause that doesn’t match how you will actually ship.
Further Reading
Sources
- ICC Academy: Documentary credits: Rules, guidelines & terminology
- ICC Digital Library: UCP 600
